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Fighting over the cutlery: if you hold a performance bond, and the contract is terminated, can you keep it?

Terminating a contract can be as awkward and confusing as a break up – except rather than saying "It’s not you, it’s me" in contractual bust ups it is more like "It’s not me, it’s you!".

Performance bonds such as bank guarantees and letters of credit are supposed to make the whole process easier but you can still easily find yourself tied up in the courts. In Lucas Drilling Pty Limited v Armour Energy Limited it was the Queensland Court of Appeal’s turn to clean up the mess.

Background

Lucas was a drilling contractor hired by Armour. Armour had to obtain a bank guarantee of $750,000 when the parties entered into a drilling contract, on terms that if Armour failed to pay an undisputed invoice then Lucas could call on the bond. If the contract was terminated Lucas had to return the bond to Armour.

Armour became unhappy with Lucas’ performance and terminated the contract under the default provisions. At the time Armour owed Lucas $1.2 million. When Lucas called on the bond, Armour commenced proceedings to restrain Lucas.

Decision

Armour argued that any right that Lucas had to call on the bond expired on termination, so it had to return it to Armour. Lucas argued that, at the time of termination, it had accrued rights in respect of the bond since there were unpaid amounts owed by Armour, and those rights did not die with the contract. The court agreed and ordered the bond to be paid to Lucas.

Principles

The decision churned out a number of pretty important principles for parties to commercial agreements involving performance bonds:

Terminating for breach doesn’t mean that the contract never happened; accrued rights generally survive termination. We think you should ensure your contract has a survival clause to clarify which provisions are intended to remain in force after termination.

Performance bonds were once considered to be "as good as cash". If you want to put restrictions on a party’s ability to call on a bond then be very clear about it.

Contracts need to be actively managed rather than put in a drawer after signing. Things change, and you need to be on top of your rights and obligations at all times.